Session 1 Flashcards
(21 cards)
How does accounting support capital markets?
- By providing reliable financial information.
- Corporations get funding (loans, bonds, stocks) and repay with interest/dividends.
- They publish financial accounts, audited by a public auditor.
- These reports offer transparent info to investors, analysts, and banks in both primary and secondary markets.
Bottom line: Accounting ensures trust and informed decisions in capital markets.
What is an Independent Auditor’s Report and what are its limitations?
- It’s a formal statement by an external auditor expressing an opinion on whether a company’s financial statements are accurate, complete, and in line with accounting standards.
- It enhances trust for investors, regulators, and stakeholders.
- Limitation: Even a clean audit can miss major frauds (e.g., Wirecard), so it’s crucial to understand audit limitations.
What do financial analysts focus on beyond reading financial statements?
- Fundamentals: Earnings, cash flow, key ratios
- Performance drivers: Business model, industry, risks
- Accounting flexibility: Varies by firm; more flexibility → more manipulation risk
- Accounting strategy: Norm consistency, estimate realism, earnings management?
Why is financial analysis still valuable if markets are said to be efficient?
Markets aren’t perfectly efficient due to bias, delays, and information overload.
- Analysts add value by identifying risks, governance issues, and accounting quality.
- They uncover hidden problems the market might miss, improving investment decisions.
What affects accounting quality and flexibility?
Rules vs. Principles:
- US GAAP (rule-based) = less flexible
- IFRS (principle-based) = more judgment-based
- Estimates (e.g., provisions, fair value) increase manipulation risk
- Enforcement strength limits abuse
- Industry context affects accounting practices
What is earnings management and how is it done?
Definition: Using accounting choices to influence earnings
Tactics:
- Accelerate or delay revenue
- Adjust depreciation/provision assumptions
- Use flexible valuation methods (e.g., fair value)
- Purpose: Hit targets, avoid losses, earn bonuses
- Risk: Distorts reality and misleads investors
What is the legal basis for accounting rules in Germany?
Core law: Commercial Code (Handelsgesetzbuch, HGB)
Additional requirements depend on:
- Legal form (e.g., public/private companies, cooperatives)
- Industry (e.g., banks, insurers may have extra rules)
- Delegated regulations (issued by ministries or authorities)
What types of financial statements exist in Germany and which rules apply?
Separate financial statements (individual firms): always use HGB
Consolidated statements (groups):
- If listed (or voluntary): use IFRS, per EU law
- If not listed & no IFRS: follow HGB
What are BaFin’s roles in enforcing financial reporting in Germany?
- Since 01.01.2022, BaFin enforces financial reporting rules
- Can re-audit listed firms’ consolidated statements
Also handles:
- Securities supervision (capital market integrity)
- Prudential supervision (banks & insurers’ soundness)
- Note: BaFin does not directly supervise non-financial firms’ accounting
What builds trust in a firm beyond audited financial statements?
- Strong corporate governance (independent board, oversight)
- Reputation & transparency (ethical behavior, open communication)
- Regulatory compliance (follows laws, shows responsibility)
- Performance-based executive pay (aligns management with shareholders)
- Clear communication (reduces uncertainty)
- Internal controls & risk management (guards against fraud and major risks)
What are the differences between financial accounting and investor relations, and how does managerial accounting fit in?
Financial Accounting (Passive):
- Legally required, past-focused reporting
- Provides standardized, trustworthy info to outsiders (e.g., via GAAP, IFRS)
Investor Relations (Active):
- Strategic, forward-looking communication
- Builds trust and influences investors (e.g., presentations, Q&As)
Managerial Accounting:
- Sits between both
- Provides internal data for decisions aligned with financial goals and market expectations
Why are sustainability (ESG) issues relevant for capital markets?
- Investors now consider Environmental, Social, and Governance (ESG) risks and opportunities.
- Issues like climate change, resource scarcity, labor conditions, and board diversity affect: Reputation, Regulatory risk, Long-term profitability, Investor interest (poor ESG = higher costs, lower interest)
- Conclusion: Sustainability impacts financial performance and investor decisions—no longer just a PR topic.
What are the key differences between German GAAP (HGB) and IFRS in purpose, dividend rules, and philosophy?
German GAAP (HGB):
- Purpose: Stewardship; focus on distributable income
- Dividends: Legally defined; from profits, carryforwards, reserves
- Philosophy: Creditor protection & prudence, Legal form over substance, Tied to tax law rules
IFRS:
- Purpose: Decision usefulness for investors; no legal role in dividends/taxes
- Dividends: No legal rules; often based on group net income
- Philosophy: No creditor protection/prudence principle, Based on agency theory, Substance over form, uses fair value for assets/liabilities
What is the difference between accounting profit and economic profit in shareholder value management?
- Accounting profit = Revenue – explicit costs
- Economic profit = Revenue – (explicit + implicit costs incl. opportunity cost)
- To create shareholder value, a firm must generate economic profit, not just accounting profit.
- It must cover the cost of capital—the return investors expect.
⚠️ Even if accounting profit is positive, value is destroyed if it doesn’t exceed this cost.
How is shareholder value measured in the short and long term?
Short-term (Operational Targets):
- Residual Income = Net income – Cost of capital
- Economic Profit = Net income – Cost of equity
- → Help track progress toward long-term value by measuring performance precisely.
Long-term (Strategic Goal):
- Discounted Cash Flow (DCF): Present value of future cash flows
- Use WACC to discount flows
- Value is created if PV of future cash flows > initial investment
How do value-based principles align management with shareholder interests?
1. Internalize shareholder goals:
- Focus on value drivers (e.g., growth, efficiency, ESG)
- Balance long- vs. short-term strategies
2. Align management systems:
- Use planning, targets, and incentives tied to value creation
- Avoid relying solely on internal KPIs
3. Communicate clearly with capital markets:
- Ensure transparency via investor relations
- Align strategy and story with market expectations
Decentralized management: Empower local units, align goals, focus on controllability
What is the 4-step internal management process and how do value drivers support it?
4-Step Internal Management Process:
- Strategy development (corporate & divisional)
- Target setting based on key value drivers
- Action plans, budgets & implementation
- Performance measurement & incentives
Value Drivers:
- Variables with biggest impact on value (e.g., profit, efficiency, growth)
- Organized in a value driver tree to align roles with outcomes
Must be:
- Specific & impact-oriented
- Measurable
- Controllable
- Goal-congruent
What are key responsibilities in implementing value-based management and designing incentive systems?
Management Accounting:
- Set metric hierarchy
- Ensure metrics are controllable, strategic, and comparable
- Allocate resources
- Define cost of capital methodology
Operational Managers:
- Translate plans into action
- Identify and execute tasks
- Lead teams
Compensation System Principles:
- Match metrics to role/hierarchy
- Reward only what can be influenced (controllability)
- Prevent excessive risk-taking and abuse
Why is Investor Relations (IR) important and what are its key functions?
Importance of IR:
- Markets aren’t fully efficient—emotion and bias matter
- Trust is vital, especially after scandals/crises
- IR bridges management and capital markets
- Clear communication shapes market perception and reduces volatility
Functions of IR:
- Communicates timely info to investors and analysts
- Maintains loyal shareholder base
- Builds favorable conditions for future financing
- Lowers cost of capital, supports long-term credibility
Objectives:
- Reflect company’s true value in share price
- Ensure transparency and compliance
- Avoid pressure-based promotion tactics
How can companies enhance market transparency and what are best practices for communication?
Purpose: Reduce info asymmetry, improve market efficiency, lower cost of capital
Tools for Transparency:
Value Reporting: Performance, environment, planning, compensation => Reports:
- Interim (semi-annual, no audit)
- Forecast (e.g., dividend guidance)
- Risk (under German Commercial Code)
- Sustainability (per EU directives)
Goes Beyond Reports: Road shows, investor days, 1-on-1s, podcasts
Best Practices for Communications:
- Understand investor motivations
- Balance disclosure benefits/risks
- Tailor messages
- Align with strategy
- Avoid overpromising
What causes the gap between market value and book value, and how can firms address it?
Causes of the gap:
- Investor expectations (growth, profit)
- Intangible assets not reflected in book value
- Market sentiment & external factors
- Conservative accounting or valuation methods
When book > market value:
- Market lacks confidence
- Economic downturns/crises
- Overstated intangibles or poor performance
How to reduce the gap:
- Improve transparency & communication
- Strengthen operations
- Focus on innovation and long-term value drivers
- Set realistic, consistent investor messaging
